ECB announces the results of its risk control framework

Wednesday 21 December 2022 13:05 CET | News

The European Central Bank (ECB) has announced the results of the most recent review of its risk control framework for collateralised credit operations.

On 24 March 2022, the Governing Council announced its decision to gradually phase out the pandemic collateral easing measures. The ECB also communicated that it would implement a new valuation haircut schedule for credit operations based on its pre-pandemic risk tolerance levels. Following the review, the ECB decided on several measures to improve the overall consistency of the risk control framework which will take effect from 29 June 2023.

The ECB has announced the results of the most recent review of its risk control framework for collateralised credit operations.

The ECB regularly reviews the framework to ensure an adequate level of risk protection and to achieve risk equivalence across asset classes. Following the Governing Council’s July 2022 decision to consider climate change risks when reviewing haircuts, from this review onwards the analysis also aims to ensure the resilience of the haircuts to climate-related financial risks.

Finally, The European Commission welcomed the decision of the ECB to be treating EU-Bonds in the same way as bonds issued by central governments and central banks under its risk control framework.

The measures to be taken

Measures aim to ensure adequate level of risk protection, improve consistency of framework, and enhance risk equivalence of assets, while ensuring collateral availability. The measures include the following:

  • Increase the valuation haircuts for marketable and non-marketable assets to return to the ECB’s pre-pandemic risk tolerance level, based on an updated risk assessment.

  • Re-assign debt instruments issued by the European Union (EU bonds) from haircut category II to haircut category I, the same as used for debt instruments issued by central governments.

  • Phase out the distinction between jumbo and other covered bonds, assigning all covered bonds and multi-cédulas to haircut category II.

  • Set the haircuts for marketable assets with a floating coupon to be equal to those with a fixed coupon.

  • Split the longest residual maturity category in the existing haircut schedule into three new categories.

  • Replace the current flat 5% theoretical valuation markdown with a maturity-graduated markdown schedule, extending its application to all theoretically valued marketable assets except those falling under haircut category I.


The use of haircuts

Central banks need to be sure that the money they lend will be paid back. The first line of defence is the agreement with the borrower regarding repayment. If the borrower fails to repay the loan, the central bank will sell the collateral. It therefore needs to be sure that it will be able to sell the collateral at a price that will cover the amount of the loan. But assets can go up and down in value and central banks may need some time to sell specific assets. A haircut therefore provides a kind of safety buffer against any loss in value and the time it takes to sell the collateral.

The Eurosystem decides what haircuts to apply to the collateral it accepts. It makes sure that the haircut is sufficient and proportionate to minimise the risk of losses.

The Eurosystem has a strict risk management process in place and the use of haircuts is just one measure among several that it takes to ensure that it does not take on any undue risk.

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Keywords: banks, risk management, central bank, regulation
Categories: Banking & Fintech
Companies: European Central Bank
Countries: Europe
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